THE Central Bank has warned that there is very limited scope for tax cuts in the forthcoming Budget. In its latest bulletin it warns that an expansionary Budget would run the risk of pushing up the rate of inflation.

The Bank warns that tax reductions in the Budget must at least be matched by restraints on public spending. Its winter bulletin, published yesterday, said that it will continue to maintain a firm exchange rate policy to bear down on inflation. However it says that it is essential that this fight against inflation is supported by policy in other areas.

The Bank cautions that inflationary dangers may already be present and says it is especially important that the Government recognise this. "The risk of higher inflation must not be understated," it says.

The Bank did not comment directly on the recent spending estimates or the plans for the Budget. But with the Government planning to increase spending by 6 per cent next year and speculation about a generous pre election Budget package, its comments appear to be a clear warning to the Government to exercise restraint.

The Bank also says that "uncomfortably high rates of expansion of mortgage credit" have been associated with a strong housing market and prices have been rising "at an undue rate" despite significant increases in housing supply.

It says that these developments have the potential to generate inflationary expectations and to increase consumer demand.

A Central Bank official said yesterday that there has been very strong growth in credit and money supply, but that the potential adverse affects of this on inflation had been lessened so far because people were holding on to their savings. "There is a monetary overhang, if you like," he said, adding that this situation may not continue.

The Bank said the economy has continued to perform well this year. The growth rate for the year as a whole is now likely to be close to 6 per cent.

It said data would seem to indicate that there is now only a small gap between the economy's potential output and actual output. However, it said the significant increases in the labour supply, associated with migration flows and greater female participation in the labour force, have limited the pressure on resources that would otherwise exist.

On the EMU issue, the Bank said Ireland is broadly on line to meet the Maastricht criteria and inflation over the past five years has averaged 2 1/4 per cent.

Notwithstanding the economy's good performance of recent years, there needs to be ongoing vigilance about satisfying the price stability criterion. "There is little room for manoeuvre," it warned.

It pointed out that although Ireland's headline inflation rate is low 1.5 per cent - the latest inflation rate using the measure for EU comparisons is 2.2 per cent. This compares with an average rate of 1 per cent for the three lowest inflation countries," it said.

However, the Bank admitted that it was "flying blind" in some respects.

While the Bank has generally intervened in the market to help keep the pound above sterling parity - thus allowing it to rise against other currencies - officials said there was nothing "sacrosanct" about any bilateral exchange rate such as the pound/ sterling rate.